personal finance: turning money into wealth, 7e (keown) chapter...

Personal Finance: Turning Money into Wealth, 7e (Keown)Chapter 15 Retirement Planning

15.1 Social Security and Employer-Funded Pensions

1) The size of your Social Security benefits are determined by your number of years of earnings, your average level of earnings, and an adjustment for inflation.Answer: TRUEDiff: 1Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

2) An employee's Social Security contributions are invested in a general fund account and will bemade available for the employee at retirement. Answer: TRUEDiff: 1Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

3) Social Security is a plan where current workers' contributions pay for current retiree's benefits.Answer: TRUEDiff: 1Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

4) The Federal Insurance Contributions Act isn't an investment, but rather a mandatory insuranceplan that one pays into through salary deductions. Answer: TRUEDiff: 3Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

5) Social Security is a health care, retirement, disability income, and life insurance plan.Answer: TRUEDiff: 3Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

6) Robin was born after 1960, therefore, the retirement age for her to receive full Social Security benefits is 65.Answer: FALSEDiff: 1Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

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7) For most people, there is really no reason to save for retirement since Social Security will provide retirement benefits until you die.Answer: FALSEDiff: 2Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

8) Most employees in the United States today are covered by an employer funded defined-benefitplan.Answer: FALSEDiff: 1Topic: Defined Benefit Retirement PlanAACSB: Information Technology

9) Under a funded pension plan, the employer makes regular contributions to a trustee who collects and invests the retirement funds.Answer: TRUEDiff: 1Topic: Employer Sponsored Retirement PlanAACSB: Information Technology

10) One of the drawbacks to defined-benefit plans are their lack of portability, meaning that if you leave the company the value of the pension is not likely to go with you.Answer: TRUEDiff: 1Topic: Defined Benefit Retirement PlanAACSB: Information Technology

11) Today, the typical American worker will receive a defined-benefit retirement plan from their employer.Answer: FALSEDiff: 2Topic: Defined Benefit Retirement PlanAACSB: Information Technology

12) Under a defined benefit plan you receive a promised or "defined" benefit payout at retirement. Answer: TRUEDiff: 2Topic: ProvisionsAACSB: Information Technology


13) Which of the following benefits is not provided by Social Security? A) DeathB) DisabilityC) EducationD) HealthE) RetirementAnswer: CDiff: 1Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

14) Which of the following statements is true regarding Social Security retirement benefits?A) It attempts to replace 42% of your average earnings.B) Not all occupations are covered.C) Some people's benefits may be taxed.D) You may retire beginning at age 62 with reduced benefits.E) All of the aboveAnswer: EDiff: 2Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

15) Social Security is a mandatory insurance program that provides a base level of protection for all of the following occurrences except one. Choose that one.A) DeathB) DisabilityC) Health problemsD) RetirementE) Job lossAnswer: EDiff: 1Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

16) Social Security is a system where current workers' pay taxes that are used to pay current retirees' benefits. How is Social Security funded?A) Income taxes by all AmericansB) Payroll taxes on employees up to a salary capC) Payroll taxes on employers up to a salary capD) All of the above are correct.E) Only B and C are correct.Answer: EDiff: 1Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments


17) To be eligible for Social Security benefits, you receive one credit for every $1,200 in wages that you earn, up to 4 credits per year. How many total credits do you need to qualify for benefits?A) 4B) 20C) 30D) 40Answer: DDiff: 1Topic: Social SecurityAACSB: Analytical Thinking

18) The system of Social Security is based on young working people paying taxes to support older retired people. The dependency ratio is the number of workers to retirees. Forty years ago itwas 16 workers for every one retiree. What will happen to this ratio by the year 2048?A) It will reverse so that there will be more retirees than workers.B) It will increase, because there will be more young workers than retirees.C) It will decline to 2 workers for every 1 retiree.D) Nothing, since the ratio of young people to old people does not change. Answer: CDiff: 2Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

19) How is the size of a person's Social Security retirement benefits determined?A) It depends on the number of credits earned in a person's lifetime.B) It depends on the average level of earning over a person's lifetime.C) It depends on the number of years a person has paid Social Security taxes.D) All of the above are correct.E) Only B and C are correct.Answer: DDiff: 2Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

20) Many older companies have changed from a defined-benefit plan to a(n) ________, which is a retirement plan where workers are credited with a percentage of their pay each year, plus a predetermined rate of interest.A) funded pension planB) cash balance planC) unfunded pension planD) percentage plus inflation planE) none of the aboveAnswer: BDiff: 3Topic: Employer Sponsored Retirement PlanAACSB: Information Technology


21) Your company pays retirement benefits to current retirees out of current earnings, on a pay-as-you-go basis. This is an example of a(n)A) unfunded pension plan.B) funded pension plan.C) cash balance plan.D) none of the above.Answer: ADiff: 2Topic: Employer Sponsored Retirement PlanAACSB: Information Technology

22) When an employer makes pension fund contributions directly to a trustee who holds and invests those funds, the plan is said to be a(n)A) defined-contribution plan.B) funded pension plan.C) unfunded pension plan.D) cash balance plan.E) none of the above.Answer: BDiff: 1Topic: Employer Sponsored Retirement PlanAACSB: Information Technology

23) Frank is considering a new job. However he is concerned about his pension fund. He knows that ________ which is the requirement that he must work for his firm for a specified period of time prior to gaining ownership of the retirement contributions made by his employer has to be met first. A) tenuringB) certifyingC) vestingD) validatingE) none of the aboveAnswer: CDiff: 1Topic: ProvisionsAACSB: Information Technology


24) If your pension fund contained a provision that allowed employees who were leaving the company to retain and transfer any pension benefits earned to another pension plan, it would be said to haveA) transference.B) releasability.C) transportance.D) portability.E) none of the above.Answer: DDiff: 1Topic: ProvisionsAACSB: Information Technology

25) With a ________, you, and usually your employer, pay funds into your retirement plan.A) deducted-benefit planB) noncontributory retirement planC) contributory retirement planD) none of the aboveAnswer: CDiff: 1Topic: Employer Sponsored Retirement PlanAACSB: Information Technology

26) A ________ is defined by the fact that your employer provides all the funds for the retirement plan, without any contribution from you.A) defined-benefit planB) noncontributory retirement planC) contributory retirement planD) portableE) none of the aboveAnswer: BDiff: 1Topic: Employer Sponsored Retirement PlanAACSB: Information Technology

27) Which of the following is a problem associated with many defined-benefits programs?A) Lack of portabilityB) Failure to adjust for inflation once payments beginC) Many are unfunded.D) All of the aboveE) A and C onlyAnswer: DDiff: 3Topic: Employer Sponsored Retirement PlanAACSB: Analytical Thinking


28) Defined-benefit pension plans are generally ________ and they lack ________.A) contributory; divestingB) noncontributory; divestingC) contributory; portabilityD) noncontributory; portabilityE) vested; portabilityAnswer: DDiff: 3Topic: Employer Sponsored Retirement PlanAACSB: Information Technology

29) Why have many companies switched from traditional defined-benefits plans to cash-balance plans?A) They want to shower their employees with moneyB) Regulatory reform made it necessary.C) They save money with them as a result of reduced future benefits for older workers.D) All of the above are correct.E) Only B and C are correct.Answer: CDiff: 3Topic: Defined Benefit Retirement PlanAACSB: Information Technology

30) How will you access in an accurate manner the amount of your retirement income?Answer: Call Social Security at 800-772-1213 for a Personal Earnings and Benefits Estimate Statement to see what your monthly check will be. Go to your employer's benefits office and request a similar statement relative to your retirement. Use a financial calculator or a computer program to calculate all of your investments and savings. Go to the Social Security Administration's on-line website to access additional information.Diff: 1Topic: Social SecurityAACSB: Information Technology

31) How does Uncle Sam determine our Social Security monthly retirement check for all practical purposes?Answer: Our number of years of earnings, average level of earnings, and an adjustment for inflation all go into the calculation of our retirement benefit. SS attempts to replace 42% of our average earnings over the working years.Diff: 1Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments


32) Explain why we do not invest in Social Security. What are the four basic benefits for those who are qualified?Answer: We actually purchase mandatory insurance, rather than invest, in Social Security. It can provide benefits for death, disability, health problems, and retirement.Diff: 2Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

33) Social Security benefits are very nice to get and help many current retirees live above the poverty line. Why should someone who is 25 years old today not count on receiving the same type of Social Security benefits when they retire in 45 years from now?Answer: The demographics of American society have changed dramatically since when Social Security was created in 1933. The two main problems is the dependency ratio of young workers for every one retiree and the fact that the average life expectancy of retirees is increasing quickly.In 1933 the average life expectancy was 65 years old. The idea that 40 young working families would pay a small amount of taxes to support one retiree for a relatively short period of time. The current life expectancy is increasing meaning current retirees are drawing benefits much longer than expected. This is due to tremendous improvements in lifestyles, diets, health care, medicine and technology. If this trend continues then life expectancies will keep increasing causing serious financial strains on the system as it is now. Plus families are having fewer children causing the dependency ratio of workers to retirees to keep shrinking and is projected to be 2 to 1 in forty years. Some economists believe that the retirement age needs to raised up well past 70 rather than future benefits be reduced.Diff: 3Topic: Social SecurityAACSB: Diverse and Multicultural Work Environments

34) Relate the pros and cons of defined-benefit plans.Answer: Under a defined-benefit plan you receive a promised pension payout at retirement. Some employers pay for it 100%. The money grows tax-deferred. The employer bears the risk and you are promised the same amount regardless of the market. You may become vested in these plans, which is what you want in the first place.In general, the most that any employee gets is 40% to 45% of his or her before-retirement income. Companies can change their position or policy with little notice. The plans lack portability, that is, the ability to move with you to your new job. Very few of them adjust for inflation and some are not funded.Diff: 2Topic: Employer Sponsored Retirement PlanAACSB: Reflective Thinking


15.2 Plan Now, Retire Later

1) Because inflation makes goods and services cost more over time, one would be wise to alwaysplan for inflation when planning one's retirement. Answer: TRUEDiff: 1Topic: Planning for RetirementAACSB: Diverse and Multicultural Work Environments

2) One of the first steps in planning for your retirement is figuring out just what you want to do when you retire.Answer: TRUEDiff: 1Topic: Planning for RetirementAACSB: Reflective Thinking

3) One of the best things about retirement is that retirees don't have to pay income taxes once they retire.Answer: FALSEDiff: 1Topic: Planning for RetirementAACSB: Diverse and Multicultural Work Environments

4) Since the 2000s, the average personal savings rate in the U.S. has decreased. Answer: FALSEDiff: 2Topic: SavingAACSB: Reflective Thinking

5) According to the Employee Benefit Research Institute, one-third of U.S. households between the ages of 30 and 59 won't have enough money for retirement, even if they work until they're 70.Answer: TRUEDiff: 3Topic: Planning for RetirementAACSB: Reflective Thinking

6) As of 2014, the average monthly Social Security benefit for retired workers was A) $959.B) $1,150.C) $1,294.D) $1,677.Answer: CDiff: 2Topic: Social SecurityAACSB: Reflective Thinking


7) Suppose that you have estimated that, to provide for your retirement income, you will need $2,250,000 on deposit in your retirement account when you retire. You believe that you will earn an average of 11% on your retirement investments until you retire in 35 years. What must your annual deposits be to accumulate this total?A) $21,991.14B) $6,586.85C) $5,904.84D) $6,878.77E) None of the aboveAnswer: BDiff: 3Topic: Planning for RetirementAACSB: Analytical Thinking

8) Like many Americans you know that you must plan your retirement funds carefully because there may be a discrepancy between the funds that you will need to survive on during retirement and the income that you will have available during retirement. What will likely be the relationship between fund needs and income available during retirement for MOST Americans? A) They will match.B) They will be close.C) They will not be close — income will be greater than needs.D) They will not be close — needs will be greater than income. Answer: DDiff: 2Topic: Planning for RetirementAACSB: Diverse and Multicultural Work Environments

9) You have determined that you will need to accumulate $1,000,000 in your retirement account in order to cover your inflation-adjusted shortfall. Which of the following is closest to the amount of money you would need to put into a tax-deferred retirement account every year if you plan on retiring in 40 years? Assume an 8% average return on this account, and that it is empty today.A) $1,458B) $3,860C) $5,957D) $8,444Answer: BDiff: 3Topic: Planning for RetirementAACSB: Analytical Thinking


10) ________ of workers feel confident they will have enough money to live comfortably in retirement, only ________ have actually tried to calculate how much they will need when in retirement.A) 50 percent; 33 percent B) 70 percent; 43 percentC) 85 percent; 53 percentD) 90 percent; 73 percent Answer: BDiff: 3Topic: Planning for RetirementAACSB: Reflective Thinking

11) What investment goals should a person have when determining where to put their 401k monies in their account?Answer: For the younger workers under the age of 55, their goal should be the accumulation of wealth through capital gains. A good diversified portfolio of Index funds, Growth funds and Balance funds would be appropriate choices. Between ages 55 and 65, their goals should change to wealth preservation so they should gradually reallocate their portfolio away from capital gains to less volatile funds like bond funds so that by the time they near retirement they have 70% into Bond funds and 30% into Balanced funds. Once retired, wealth preservation and income are the main goals so they should have a majority of their portfolio in Bond funds and Government Security funds for safety and income.Diff: 3Topic: Defined Contribution Retirement PlanAACSB: Reflective Thinking

12) Relate the 7 steps to funding your retirement needs. What is the hardest part?Answer: 1. Set realistic and well thought out goals.2. Estimate how much you will need to meet your goals.3. Estimate your income available at retirement.4. Calculate the annual inflation-adjusted shortfall.5. Calculate funds needed at retirement to cover this shortfall over your entire retirement.6. Determine how much you must save annually between now and retirement.7. Put the plan in play and save.The hardest part always seems to be getting started.Diff: 2Topic: Planning for RetirementAACSB: Reflective Thinking


13) Discuss the basic considerations when facing retirement.Answer: Make sure you meet the qualifications to begin receiving payments. Decide on the typeof payout you want and its tax consequences. Look at all payout options because you may want acombination payout. Once you receive these funds, make sure you understand investing, diversification, the time dimension of risk, and what you want to do with them.Diff: 1Topic: Planning for RetirementAACSB: Reflective Thinking

15.3 Retirement Plans

1) The only difference between a defined-benefit plan and a defined-contribution retirement plan is the tax deduction for the defined-contribution plan.Answer: FALSEDiff: 2Topic: Defined Contribution Retirement PlanAACSB: Information Technology

2) Under a defined-contribution plan, your employer alone or you and your employer together contribute directly to an individual account set aside specifically for you.Answer: TRUEDiff: 1Topic: Defined Contribution Retirement PlanAACSB: Information Technology

3) A 401(k) plan is a tax-deferred retirement savings plan in which employees of private corporations may contribute a portion of their wages up to a maximum amount set by law.Answer: TRUEDiff: 1Topic: Defined Contribution Retirement PlanAACSB: Information Technology

4) The big disadvantage with a defined-contribution plan is that you don't know in advance exactly how much money you can plan on for retirement income.Answer: TRUEDiff: 3Topic: Defined Contribution Retirement PlanAACSB: Information Technology

5) By law, everyone must contribute the maximum amount into their 401(k) plans at work.Answer: FALSEDiff: 2Topic: Defined Contribution Retirement PlanAACSB: Diverse and Multicultural Work Environments


6) You should take advantage of any matching your company is willing to do for your 401(k).Answer: TRUEDiff: 2Topic: Defined Contribution Retirement PlanAACSB: Analytical Thinking

7) According to the author, 401(k) plans are actually do it yourself variation of a profit-sharing/thrift plan. Answer: TRUEDiff: 2Topic: Defined Contribution Retirement PlanAACSB: Information Technology

8) The Keogh plan is a retirement plan for individuals who work for large multinational corporations.Answer: FALSEDiff: 1Topic: IRS Qualified Retirement PlansAACSB: Diverse and Multicultural Work Environments

9) It is a good idea to start saving for retirement as early as possible to take advantage of compounding returns on your savings.Answer: TRUEDiff: 1Topic: Planning for RetirementAACSB: Reflective Thinking

10) Individual retirement arrangements (IRAs) are personal savings accounts that give you tax advantages for saving for retirement.Answer: TRUEDiff: 1Topic: IRS Qualified Retirement PlansAACSB: Analytical Thinking

11) Anyone can open up an IRA account but not everyone may get tax-advantages from it because there are income limitations.Answer: TRUEDiff: 1Topic: IRS Qualified Retirement PlansAACSB: Analytical Thinking

12) Contributions to a traditional IRA are always tax deductible.Answer: FALSEDiff: 1Topic: IRS Qualified Retirement PlansAACSB: Diverse and Multicultural Work Environments


13) If all contributions to your IRA are tax deductible, then all withdrawals from your IRA will be taxed, unless you're just moving your money into another IRA.Answer: TRUEDiff: 1Topic: IRS Qualified Retirement PlansAACSB: Analytical Thinking

14) A person may have more than one qualified retirement plan open at the same time.Answer: TRUEDiff: 1Topic: IRS Qualified Retirement PlansAACSB: Analytical Thinking

15) A 'self-directed' retirement plan is one in which a plan administrator determines how much your contributions will be and what investment options you will have available.Answer: FALSEDiff: 2Topic: IRS Qualified Retirement PlansAACSB: Analytical Thinking

16) With a traditional IRA and a Roth IRA, you can make withdrawals at any time with no penalties.Answer: FALSEDiff: 2Topic: IRS Qualified Retirement PlansAACSB: Information Technology

17) With a Roth IRA, after five years you can make withdrawals before age 59 1/2 without a penalty but you must pay taxes on the withdrawals.Answer: FALSEDiff: 3Topic: IRS Qualified Retirement PlansAACSB: Information Technology

18) The Savers Tax Credit is designed to encourage low to moderate income workers contribute to their retirement accounts.Answer: TRUEDiff: 2Topic: Planning for RetirementAACSB: Reflective Thinking

19) A Coverdell Education Savings Account works just like the Roth IRA for qualified educationexpenses, except with respect to contributions.Answer: TRUEDiff: 2Topic: Savings for CollegeAACSB: Information Technology


20) With an IRA your investment choices include stocks, bonds, mutual funds, CDs and real estate. Answer: TRUEDiff: 2Topic: Planning for RetirementAACSB: Information Technology

21) If you have a defined-benefit retirement plan, you're considered an "inactive participant."Answer: FALSEDiff: 2Topic: IRS Qualified Retirement PlansAACSB: Information Technology

22) For someone wanting to minimize the taxes they are paying now, a Roth IRA would be preferable to a traditional IRA.Answer: FALSEDiff: 3Topic: IRS Qualified Retirement PlansAACSB: Diverse and Multicultural Work Environments

23) Contributions to Roth IRAs are tax deductible. Answer: FALSEDiff: 3Topic: IRS Qualified Retirement PlansAACSB: Diverse and Multicultural Work Environments

24) The Roth IRA does not require that distributions begin by age 70 1/2.Answer: TRUEDiff: 3Topic: IRS Qualified Retirement PlansAACSB: Diverse and Multicultural Work Environments

25) One of the advantages to a traditional IRA is that it allows you to make a penalty-free withdrawal to purchase your first home.Answer: TRUEDiff: 3Topic: IRS Qualified Retirement PlansAACSB: Information Technology

26) The main advantage of the Roth IRA over the traditional IRA is the employer matching funds.Answer: FALSEDiff: 3Topic: IRS Qualified Retirement PlansAACSB: Diverse and Multicultural Work Environments


27) A(n) ________ is a tax-deferred retirement plan that is essentially the same as a 401(k) plan, except that it is aimed at employees of schools and charitable organizations.A) 404(a)B) 402(b)C) 403(b)D) 007(a)E) none of the aboveAnswer: CDiff: 1Topic: IRS Qualified Retirement PlansAACSB: Information Technology

28) A(n) ________ is a pension plan in which you and your employer or your employer alone contribute funds directly to a retirement account set aside specifically for you.A) defined-benefit planB) cash balance planC) defined-contribution planD) percentage plus inflation planE) none of the aboveAnswer: CDiff: 1Topic: Defined Contribution Retirement PlanAACSB: Information Technology

29) Brian works for Walmart. Walmart contributes company stock into his retirement account instead of cash. This is called a(n)A) ESOP.B) thrift.C) EFLP.D) stock-contribution plan.E) none of the above.Answer: ADiff: 1Topic: Employer Sponsored Retirement PlanAACSB: Information Technology

30) You are participating in a pension plan where the company's contributions vary from year to year, depending on the firm's performance. This is an example of a(n)A) variable contribution plan.B) earnings establishment plan.C) performance retirement plan.D) profit-sharing plan.E) none of the above.Answer: DDiff: 1Topic: Employer Sponsored Retirement PlanAACSB: Information Technology


31) Burt Reynolds has changed jobs. His last retirement plan's contributions depended on how well the company performed and he shared in the earnings. His present employer allows him ownership in the firm, although this is the riskiest plan. Burt's former plan was a(n) ________ and his current plan is a(n) ________.A) ESOP; money purchase planB) profit-sharing plan; ESOPC) ESOP; 401(k)D) profit-sharing plan; thrift and savings planE) ESOP; profit sharing planAnswer: BDiff: 2Topic: Employer Sponsored Retirement PlanAACSB: Information Technology

32) Why does a tax-deferred retirement account accumulate more money than a taxable account, assuming the same amount is contributed every year and the accounts earn the same return every year?A) There are different investment options available for tax-deferred accounts.B) You can take bigger risks with assets that generate higher returns in a tax-deferred account.C) With tax-deferred accounts, there are no income or capital gains tax liabilities on account activity.D) All of the above are correctE) Only A and B are correct.Answer: CDiff: 3Topic: IRS Qualified Retirement PlansAACSB: Diverse and Multicultural Work Environments

33) Why have employers switched to defined-contribution plans instead of defined-benefits plansfor most companies?A) They remove the financial risk for future pension costs away from the company and pass it onto the employee.B) The employer doesn't want to do any bookkeeping for the retirement plan.C) Employers care deeply about what employees eventually receive from their plan.D) All of the above are correct.E) Only A and B are correct.Answer: ADiff: 2Topic: Defined Contribution Retirement PlanAACSB: Diverse and Multicultural Work Environments


34) Tran is employed at a company that annually contributes anywhere from 2% up to 12% of his salary into his retirement plan, depending on how good the company's financials were that year. This type of contribution plan is a(n) ________ plan.A) 401(k)B) ESOPC) profit-sharingD) performanceAnswer: CDiff: 2Topic: Employer Sponsored Retirement PlanAACSB: Diverse and Multicultural Work Environments

35) A(n) ________ retirement plan is one in which the company will contribute shares of company stock into the employee's account in place of a cash contribution. The employee does well if the company stock appreciates in value, but can suffer dramatically if the stock depreciates in value.A) 401(k) stock accountB) 403(b) stock accountC) ESOPD) stock repurchase planAnswer: CDiff: 2Topic: Employer Sponsored Retirement PlanAACSB: Diverse and Multicultural Work Environments

36) 401(k) and 403(b) plans are the most common retirement plans these days. What are the big advantages to employees with these plans?A) You don't pay taxes on money contributed to 401(k) plans.B) Earnings on your retirement account are tax deferred.C) Many firms contribute an employer match, which represents a 100% risk-free return to the employee.D) All of the above are correct.E) Only A and C are correct.Answer: DDiff: 2Topic: Defined Contribution Retirement PlanAACSB: Diverse and Multicultural Work Environments


37) The difference between a Money Purchase Plan and a Profit Sharing plan is thatA) with the Profit Sharing Plan the employee is guaranteed to see profits in their retirement funds.B) with the Money Purchase Plan the contributions are required regardless of how the firm performs.C) Profit Sharing Plans constantly outperform Money Purchase Plans.D) all of the above are correct.E) both A and C are correct.Answer: BDiff: 2Topic: Defined Contribution Retirement PlanAACSB: Diverse and Multicultural Work Environments

38) Jahwana works for a large corporation with a 401(k) retirement plan. The company matches dollar for dollar the first 5% of the employee's salary contributed to the 401(k). Jahwana currently earns $40,000 in gross salary and she currently contributes 15% of her salary into her 401(k). How much money in dollars is the total contribution to her account every year?A) $2,000B) $4,000C) $6,000D) $8,000Answer: DDiff: 3Topic: Defined Contribution Retirement PlanAACSB: Analytical Thinking

39) Alex works for a company with a 401(k) plan. He currently earns $80,000 in gross salary andcontributes 8% of his gross salary into his 401(k) account. If his marginal tax rate is 33%, how much income tax liability is he saving by participating in his 401(k)?A) $6,400B) $2,112C) $6,000D) $16,800Answer: BDiff: 3Topic: Defined Contribution Retirement PlanAACSB: Analytical Thinking


40) Erica works for a company with a 401(k) plan. The company matches at $0.50 on the dollar the first 6% of the employee's salary contributed to the 401(k). If Erica earns $90,000 and contributes 12% of her salary, how much will the employer match be in dollars for the year?A) $1,400B) $2,700C) $3,500D) $6,200Answer: BDiff: 3Topic: Defined Contribution Retirement PlanAACSB: Analytical Thinking

41) What are the disadvantages of an ESOP retirement plan?A) Your retirement account is not diversified.B) The return on your account is subject to the success of the company.C) If the company files for bankruptcy, the stock in your account could become worthless.D) All of the above are correct.E) Only A and C are correct.Answer: DDiff: 3Topic: Employer Sponsored Retirement PlanAACSB: Reflective Thinking

42) Valerie works as a free-lance artist. Her financial advisor suggested she establish a Keogh plan for her retirement. Is this an appropriate suggestion for her? A) YesB) NoAnswer: ADiff: 2Topic: IRS Qualified Retirement PlansAACSB: Diverse and Multicultural Work Environments

43) Of the tax-favored retirement plans for the self-employed and small business employee, one is limited to $52,000 of annual contributions per person. It is the ________ plan.A) KeoghB) SEP-IRAC) SIMPLED) 401(k)E) thriftAnswer: BDiff: 3Topic: IRS Qualified Retirement PlansAACSB: Diverse and Multicultural Work Environments


44) If you are self-employed or work for a small business which of the following retirement plans would you be most likely to have?A) 403(b)B) 401(k)C) Thrift and savings planD) Keogh planE) None of the aboveAnswer: DDiff: 1Topic: IRS Qualified Retirement PlansAACSB: Information Technology

45) Which of the following retirement plans is designed for small businesses?A) SIMPLE plansB) SEP-IRA plansC) ESOPD) All of the aboveE) Only A and BAnswer: EDiff: 2Topic: IRS Qualified Retirement PlansAACSB: Information Technology

46) What are the advantages to a SIMPLE plan for retirement for the small business owners? A) The plan is very easy to set up. B) The plan works well for small business owners with 100 employees or less.C) The small business owner has some flexibility in determining how much to contribute to the plan.D) All of the above are correct.E) Only A and B are correct.Answer: DDiff: 3Topic: IRS Qualified Retirement PlansAACSB: Analytical Thinking

47) Rihab just got a new job and wants to roll over her retirement account from her previous job at a large corporation into an IRA. Which of the following is true?A) Doing this avoids the 10% early distribution penalty.B) Rihab should speak to a financial planner to learn make sure she follows the rollover rules to avoid taxes.C) Both A and BD) Neither A nor BAnswer: CDiff: 3Topic: IRS Qualified Retirement PlansAACSB: Diverse and Multicultural Work Environments


48) What advantage does the Roth IRA have over the traditional IRA? A) Early withdrawals from a Roth are subject to penalities, so you won't be tempted to dip into your investment.B) Unlike the traditional IRA, with a Roth you don't pay taxes while your money is in the IRA.C) With a Roth you take care of taxes ahead of time and end up with more money to spend at retirement.D) Contributions to a Roth IRA are tax deductible. Answer: CDiff: 3Topic: IRS Qualified Retirement PlansAACSB: Diverse and Multicultural Work Environments

49) You want to start an Coverdell Education Savings Account for your child. Suppose that you contribute $500 each year to this account for 18 years, starting when he or she is born. If you canearn 8% on the deposits, how much will be on deposit at the end of the 18th year?A) $4,306.38B) $17,581.05C) $18,725.12D) $3,682.89E) none of the aboveAnswer: CDiff: 3Topic: Savings for CollegeAACSB: Analytical Thinking

50) Reggie has two children. He is wanting to put money away for their college education. What type of plan can only be used for college and graduate school, and allows contributions of up to $250,000?A) 403(b)B) ESOPC) 529D) 12b-4Answer: CDiff: 1Topic: Savings for CollegeAACSB: Diverse and Multicultural Work Environments


51) What is a disadvantage of the "Prepaid College Tuition Plan" version of the 529 plan? A) Distributions before age 59 1/2 incur a 10% tax penalty.B) They generally guarantee that your child will be covered only if he or she attends a public in-state university or college. C) They allow greater flexibility than the College Savings Plans. D) All of the above.E) None of the above. Answer: BDiff: 2Topic: Retirement PlanAACSB: Information Technology

52) Frances McClurg favors the Roth IRA over the traditional IRA. What advantage does the Roth provide over the traditional IRA?A) She can avoid income taxes when she withdraws.B) The earnings are tax deferred, unlike a traditional IRA.C) Contributions are tax deductible.D) It saves tax money for education.Answer: ADiff: 1Topic: IRS Qualified Retirement PlansAACSB: Analytical Thinking

53) Lori Watts favors the traditional IRA over the Roth IRA. What advantage does the traditionalIRA have over the Roth? A) The earnings are tax-exempt, unlike a Roth IRA.B) Contributions are likely to be fully or partially tax deductible.C) It saves tax money for education.D) There are no penalties for early withdrawals.Answer: BDiff: 2Topic: IRS Qualified Retirement PlansAACSB: Analytical Thinking

54) Which of the following statements about saving for college is not true?A) The Coverdell Education Savings Account works just like the Roth IRA, except with respect to contributions.B) If the money in a Coverdell Education Savings Account isn't used for college, taxes and penalties may apply.C) Some 529 plans are prepaid college tuition plans.D) You must open a 529 plan sponsored by the state in which you reside.E) 529 college savings plans offer more flexibility than prepaid college tuition plans.Answer: DDiff: 2Topic: Savings for CollegeAACSB: Information Technology


55) Jose does not have a retirement plan at work. He currently earns $30,000 in salary and is in the 15% marginal tax bracket. If he contributes the maximum contribution of $5,500 to his traditional IRA, how much money will he save on his income tax liability?A) He won't save any money, since only the Roth IRA has tax deductions on contributions.B) He won't save any money, since his income does not qualify for tax deductions for a qualified plan.C) $825D) $5000Answer: CDiff: 2Topic: IRS Qualified Retirement PlansAACSB: Analytical Thinking

56) Alicia works two jobs and still makes very little income. Why is the Saver's Tax Credit a good idea for her? A) Because it will possibly increase her tax refundB) Because it will possibly reduce the amount of income tax that she owesC) It allows her to offset part of the first $2,000 that she can contribute to an IRA or a 401(k) plan. D) All of the above are correct.E) Only A and B are correct.Answer: DDiff: 2Topic: IRS Qualified Retirement PlansAACSB: Analytical Thinking

57) June and Ward Cleaver are married. June works as an accountant and contributes to a 401(k) plan at work. Ward is a web page designer and works for himself from their home. What type of retirement plan would be an option for Ward?A) Keogh planB) SEP-IRA planC) Individual IRAD) All of the above are correct.E) Only A and C are correct.Answer: DDiff: 2Topic: IRS Qualified Retirement PlansAACSB: Analytical Thinking


58) If you have a defined-benefit retirement plan through your place of employment, you are considered a(n) ________; and as such, there is an income limit after which your IRA contributions are no longer tax deductible. A) restricted participantB) deactivated participantC) active participantD) All of the above are correct.E) Only A and C are correct.Answer: CDiff: 3Topic: IRS Qualified Retirement PlansAACSB: Information Technology

59) Fred and Carlie want to save some money for a down payment on a house. They figure it willtake at least 10 years to save up enough money. Which of the following would be the best way for them to save this money?A) Traditional IRAB) Roth IRAC) 529 Savings PlanD) Keogh PlanAnswer: BDiff: 3Topic: IRS Qualified Retirement PlansAACSB: Information Technology

60) What are the advantages and disadvantages of a defined-contribution plan like a 401k?Answer: The big advantages are the tax-deductibility of your contributions, the tax-deferred treatment during your working years, and the employer match if any. With wise investment decisions and consistent contributions an employee can accumulate a substantial amount of retirement funds over the long haul. Portability and vesting are also very important benefits sincemost younger workers will switch jobs throughout their working lives.

The big disadvantages are not knowing what your retirement income will be upon retirement, poor investment decisions and market swings close to retirement. Many people are not very sophisticated with investing and they choose investment options that are either to risky or to conservative for their life cycle stage. Many people don't contribute the maximum allowed to get the full benefits of the employer match or the maximum accumulation over time.Diff: 2Topic: Defined Contribution Retirement PlanAACSB: Analytical Thinking


61) Compare and contrast the defined-contribution plans.Answer: Under profit-sharing plans your employer contributes a portion of the company's profits to your individual plan. Things are great when there is a profit and not so great when thereis none. Money purchase plans have a guaranteed contribution by the employer of a set percentage of each employee's salary. Employers match a percentage of employee's contributionsin a thrift-and-savings plan. An ESOP is the riskiest plan. Here, your company contribution consists of the company's stock. If the firm goes broke you lose everything. A 401(k) plan is a tax-deferred retirement plan in which both the employee's contributions and earnings are tax-deductible.Diff: 1Topic: Employer Sponsored Retirement PlanAACSB: Analytical Thinking

62) Are retirement plans different for the self-employed and employees of small businesses? Do you have to work full-time to qualify for one?Answer: Both part-time and full-time small business owners and employees can qualify for one of three tax-favored retirement plans. A Keogh plan allows large tax-deductible contributions to either a defined-contribution or a defined-benefit or a combination of both plans. Under a defined-benefit Keogh you are allowed to contribute whatever amount you deem necessary to meet your needs. A SEP-IRA is similar to a Keogh and is easier to set up, but contributions are more limited. A SIMPLE plan provides some employer matching funds, is for businesses with less than 100 employees, and is very simple to set up and use.Diff: 3Topic: IRS Qualified Retirement PlansAACSB: Reflective Thinking

63) What does the term 'self directed' mean concerning retirement accounts?Answer: The term self directed means that the individual account holder will make the investment decisions for their retirement monies. For employer sponsored plans, the employer will select a Financial Institution like a Mutual Fund company to be the plan Administrator. Typically there will be a selection of various mutual fund categories available to meet the requirements of a diverse group of employees. It is the employee who chooses which fund or funds they feel are best suited to their individual needs, hence they are 'self directing' their retirement account.

With an individual retirement account, the individual makes all of the choices themselves. They choose a Financial Institution to act as the Plan Administrator and the individual chooses whatever investments they want for their account.Diff: 3Topic: Planning for RetirementAACSB: Reflective Thinking


64) What are the major differences between the new IRAs and the traditional IRA?Answer: All three of them are on a tax-deferred basis for individuals. They are separate from any employer plan. The traditional IRA can be fully tax-deductible, partially tax-deductible, or not tax-deductible, depending on the amount of your earnings and whether your spouse or you yourself have a company retirement plan. The Roth IRA does not have tax-deductible contributions, but rather has tax-free withdrawals upon retirement. The Coverdell Education Savings Account (Education IRA) is just like the Roth IRA except that contributions are limited to $2000 annually per child for each child younger than 18. Diff: 1Topic: IRS Qualified Retirement PlansAACSB: Reflective Thinking

65) Why is it a wise idea to have 3 retirement plans in place?Answer: The three-retirement-plan idea is worthy of consideration for several reasons. We may misjudge our retirement needs and it never hurts to have a little extra. It is far better to have too much than too little. The Social Security system may be under such a strain that benefits may be scaled back, thus making an additional source of income necessary. Our employer's plan or plansmay not hold up for several reasons. All of this will prevent us from working part or full-time in later years, but we may not be able to work during our retirement years.Diff: 3Topic: Planning for RetirementAACSB: Analytical Thinking

66) What is the purpose of a rollover when it comes to retirement plans?Answer: With the popularity of defined-contribution plans these days, employees need some way to make their retirement plans portable so they can take their retirement money with them when they leave the company before retirement. Since qualified retirement plans have tax liabilities and penalties for early withdrawals, the IRS had to come up with a process for the employee to maintain their retirement monies without being penalized. Now the employee can rollover their money into another qualified plan without any taxes or penalties. There are strict rules governing rollovers so it pays to get professional advice to avoid any tax consequences.Diff: 3Topic: IRS Qualified Retirement PlansAACSB: Information Technology

67) How does one set up a qualified individual retirement account?Answer: Because of the IRS regulations concerning tax-advantaged retirement accounts, you must set up an account with a Plan Administrator such as a Bank, Mutual Fund or other FinancialInstitution. The Plan Administrator ensures that all IRS regulations are followed and provides theIRS and account holder with the appropriate tax documents. Typically there is a nominal fee or minimum starting deposit to open up an individual retirement account.Diff: 2Topic: IRS Qualified Retirement PlansAACSB: Analytical Thinking


15.4 Facing Retirement - The Payout

1) Under a single life annuity, you receive a set monthly payment for the rest of your life.Answer: TRUEDiff: 1Topic: AnnuityAACSB: Information Technology

2) Through the single life annuity, once you reach the age of 100 the annuity payments cease. Answer: FALSEDiff: 1Topic: AnnuityAACSB: Information Technology

3) The good thing about retirement is you no longer have to pay income taxes.Answer: FALSEDiff: 1Topic: PayoutAACSB: Diverse and Multicultural Work Environments

4) Under the annuity for life policy your payments will continue to your beneficiaries upon your passing up until a specified time. Answer: TRUEDiff: 1Topic: PayoutAACSB: Diverse and Multicultural Work Environments

5) Your decision on what type of annuity to purchase will have a dramatic impact on the monthlypayments you will receive upon retirement.Answer: TRUEDiff: 2Topic: AnnuityAACSB: Diverse and Multicultural Work Environments

6) With a lump-sum distribution of your retirement benefits, you must pay all of the income taxes on the entire amount up front.Answer: TRUEDiff: 2Topic: PayoutAACSB: Diverse and Multicultural Work Environments

7) Annuity payments will adjust for inflation over the years of retirement.Answer: FALSEDiff: 2Topic: AnnuityAACSB: Information Technology


8) A joint and survivor annuity provides payments for both you and your spouse. Answer: TRUEDiff: 2Topic: PayoutAACSB: Diverse and Multicultural Work Environments

9) To avoid paying income taxes on your lump-sum distribution, you could roll it over into a qualified IRA.Answer: TRUEDiff: 2Topic: PayoutAACSB: Diverse and Multicultural Work Environments

10) A disadvantage of the annuity for life plan is that the payments stop when you die, so you can't pass the money on to your heirs.Answer: FALSEDiff: 3Topic: PayoutAACSB: Information Technology

11) Relative to insurance, when a payout arrangement is made in which one receives all benefits in a single payment, this is called aA) cash payout.B) lump-sum option.C) single distribution plan.D) point plan.E) none of the above.Answer: BDiff: 1Topic: PayoutAACSB: Diverse and Multicultural Work Environments

12) Once May Lou starts receiving her $1,200 monthly annuity payments she will pay income tax as if the annuity wereA) tax-deferred.B) tax-sheltered.C) tax-exempt.D) tax-free income.E) normal income.Answer: EDiff: 2Topic: AnnuityAACSB: Diverse and Multicultural Work Environments


13) Richard Harris wants to elect the single life annuity option for retirement. His mother lived to age 92 and his dad lived to be 89. This annuity will pay Richard a set monthly payment for as long as he lives. What possible disadvantage might he face?A) There will be no inflation protection.B) There will be no flexibility for withdrawals in case of emergencies.C) The balance of the money left over upon death will not be passed on to his heirs.D) All of the above are correct.E) Only A and C are correct.Answer: DDiff: 2Topic: AnnuityAACSB: Diverse and Multicultural Work Environments

14) Why might one want to select the lump-sum payment option for one's retirement funds?A) Taking the lump-sum can be a hedge against inflation.B) The lump-sum option provides greater flexibility than other options.C) You can invest the funds and perhaps earn a higher return. D) Having access to the funds provides money for emergencies.E) All of the aboveAnswer: EDiff: 3Topic: PayoutAACSB: Reflective Thinking

15) A ________ option provides payments over the life of both you and your spouse no matter how long you live.A) single life annuityB) lump sum annuityC) joint and survivor annuityD) annuity for lifeE) combination annuityAnswer: CDiff: 1Topic: AnnuityAACSB: Information Technology

16) When planning the retirement payout, there are several options from which to choose. With the ________ option the annuity provides payments over the life of both you and your spouse. A) single life annuityB) lump sum annuityC) joint and survivor annuityD) annuity for lifeE) combination annuityAnswer: CDiff: 2Topic: AnnuityAACSB: Diverse and Multicultural Work Environments


17) You and your spouse both have good retirement plans through work and you both receive good Social Security checks based on your own incomes. If your goal is to maximize the size of your annuity check every month, which option should you choose?A) Single Life AnnuityB) Annuity for Life or Certain PeriodC) Joint and Survivor AnnuityD) All annuities have equal payment amounts, so it doesn't matter which you choose.Answer: ADiff: 2Topic: AnnuityAACSB: Reflective Thinking

18) When is rolling your lump-sum retirement benefits into an IRA a good financial decision? A) If you have taken a new jobB) If you have retired earlyC) If you don't need the funds immediatelyD) All of the above are correct.E) Only A and C are correct.Answer: DDiff: 2Topic: PayoutAACSB: Diverse and Multicultural Work Environments

19) Congratulations! You have just retired with $1.4 million dollars in your 401(k) plan. You willbe receiving a fairly large Social Security check and you have adequate personal savings outside of your 401(k) to live on for several years. You don't want to lock up your retirement money into an annuity because you want to be flexible for the future. What would be your best option?A) Purchase an early withdrawal annuity.B) Roll over the balance into a qualified IRA account.C) Hire a Certified Financial Planner for investing advice.D) All of the above are correct.E) Only B and C are correct.Answer: EDiff: 2Topic: PayoutAACSB: Diverse and Multicultural Work Environments


20) Elaborate on the basics of annuities and payouts.Answer: A single life annuity allows you to receive a set monthly payment for life. An annuity for life (with "certain period" provision) also pays for life. In addition, if you die within the set period (usually 10 or 20 years), your beneficiary will get the payments until the end of the period. This option provides a smaller payment. A joint and survivor annuity provides payments over the life of both you and your spouse. None of these options allow for any inflation protection or flexibility in payouts. A lump-sum option gives you your benefits in one single payment. It is great for inflation protection, emergency funds, access to large sums of money, and investing in other endeavors. You can roll over the lump sum into an IRA or qualified plan. The dangers are a high tax bill and spending too much of it.Diff: 2Topic: AnnuityAACSB: Reflective Thinking

21) How are distributions/payouts/settlements taxed?Answer: Annuity payouts are taxed as normal income. Lump-sum distributions can be taxed using a 5 or 10 year averaging technique. This eases your tax burden, but you still have to pay them all at once.Diff: 2Topic: PayoutAACSB: Diverse and Multicultural Work Environments

22) Why would it be a good idea to hire a Certified Financial Planner before you retire?Answer: Many people will retire with a substantial amount of money in their retirement account.Most people would benefit from expert advice before they retire since there are many complicated and important decisions to be made. Annuities may be very good choices for some people but there is not much flexibility after the decision is made. People with spouses and dependents want to make sure they make the right choice before they purchase the annuity. Theremay be serious tax liability depending on which choice you make, especially with a lump sum option.

For those that roll over their accounts into a qualified IRA account, they will benefit with investment advice to make appropriate investment decisions to protect them from market swings and inflation.Diff: 3Topic: Financial PlanningAACSB: Reflective Thinking


15.5 Putting a Plan Together and Monitoring It

1) Vanguard and Fidelity are two low-cost mutual fund families that offer Roth IRAs. Stick to them or another mutual fund family that features low costs and expenses. Answer: TRUEDiff: 2Topic: Planning for RetirementAACSB: Reflective Thinking

2) Today, there are roughly 18,000 publicly traded stock and bond funds, and for many workers, the prospect of choosing among them is paralyzing.Answer: FALSEDiff: 2Topic: Planning for RetirementAACSB: Reflective Thinking

3) For low income senior households Social Security is a very important financial asset. Answer: TRUEDiff: 2Topic: Planning for RetirementAACSB: Diverse and Multicultural Work Environments

4) As a young consumer you would be wise to be very cautious with your investing and avoid investing in stocks. Answer: FALSEDiff: 2Topic: Planning for RetirementAACSB: Diverse and Multicultural Work Environments

5) Consistently saving a little money for retirement when you are in your twenties is much better than saving a lot more money when you are in your fifties.Answer: TRUEDiff: 2Topic: Planning for RetirementAACSB: Diverse and Multicultural Work Environments

6) Two of the most important considerations when saving for retirement is the time you have to save and the return you earn on your savings.Answer: TRUEDiff: 2Topic: Planning for RetirementAACSB: Diverse and Multicultural Work Environments


7) Retirement income comes from which of the following sources? A) Social SecurityB) PensionsC) Asset incomeD) EarningsE) All of the aboveAnswer: EDiff: 2Topic: Planning for RetirementAACSB: Diverse and Multicultural Work Environments

8) Today, there are roughly ________ publicly traded stock and bond funds, and for many workers, the prospect of choosing among them is paralyzing.A) 5,000B) 8,000C) 18,000D) 23,000Answer: BDiff: 2Topic: Planning for RetirementAACSB: Reflective Thinking

9) Lucius starts saving $100 per month at age 25 and averages 6% per year compounded monthly. Hector starts saving $1,215.22 per month at age 55 and averages 6% per year compounded monthly. Who will be better off at age 65 assuming neither had in money in their account when they started?A) Lucius will have $15,476.20 and Hector will have $16,017.57 at age 65.B) Lucius will have $199,149.07 and Hector will have $163,879.34 at age 65.C) They both will have the same amount of money in their accounts at age 65.D) Not enough information available.Answer: CDiff: 3Topic: Planning for RetirementAACSB: Analytical Thinking


10) What are some very important things to monitor concerning your retirement plan, both before and after retirement?Answer: Inflation and tax policy will have an enormous impact on whether or not you will reachyour retirement goals and be able to enjoy the standard of living you planned for during retirement. Inflation changes which effects the real return on your savings. Tax policy changes which also impacts your after-tax return. Social Security reform and Medicare reform could havea dramatic impact on retirement goals. Economic conditions such as interest rates and recession can impact your investments but also the company you worked for who may be paying out your benefits or is a major holding in your ESOP plan. Maintaining a budget and not withdrawing too much money too soon could hurt your chances of not outliving your savings. Possibly delaying retirement, delaying Social Security benefits, or working part time during retirement may be necessary and identified through good planning and monitoring.Diff: 2Topic: Planning for RetirementAACSB: Reflective Thinking

11) If your employer offers a 401(k) or 403(b) plan, why should you participate?Answer: Not only are the plans convenient, many include a company match. That's free money, and you've got to take advantage of it.Diff: 2Topic: Planning for RetirementAACSB: Analytical Thinking


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